Chapter Four
Incomes Around the World
A news item you did not see in today’s news coverage: “More than 20,000 people perished yesterday of extreme poverty.” It was unreported not because it didn’t happen—it did—but because the event does not qualify as news since it occurs on average every day.[i] Additionally, virtually none of these deaths occur in the United States; almost all occur in Third World (i.e., poor) countries, and Americans typically display little interest in what happens in other countries.
Even though the focus of this book is the United States, we can learn a good deal that is relevant to us by examining, albeit briefly, conditions around the world. Inequality and poverty are by no means unique to the United States, and a consideration of the experiences of other countries puts our own problems in a much needed broader perspective.
Incomes at Home and Abroad
The United States is the wealthiest country in the world. Everyone knows that, at least in an abstract way, but few appreciate the magnitude of the gulf that separates living standards of Americans from those prevailing in much of the remainder of the world. To measure living standards for a country, we will use recent (2003) World Bank estimates of average income per capita. More precisely, we will be using Gross National Income (similar to Gross Domestic Product) per person, a very broad measure of average income.[ii]
According to the World Bank, average income in the U.S. in 2003 was $37,500 per person. For the rest of the world, comprising more than 95 percent of the world’s population, average income was $6760. The average American thus enjoys a standard of living that is more than five times as great as that realized (on average) by the 19 out of 20 people on earth who live in other countries. Put succinctly, most of the world is extremely poor by American standards.
Of course, these averages conceal a great deal of variation that exists both among and within individual countries. The United States is not the only wealthy country; there are several others (such as Germany, Japan, United Kingdom, and France) where incomes stand at roughly three-fourths the level in the U.S., and one (Norway) with an average income nearly equal to the U.S. If we define as “high income” any country with an average income of at least half the U.S. level, then there are 23 countries which meet this standard. All together, they contain 13 percent of the world’s population. Thus, seven eighths of the people on earth live in countries where the average income is less than half that in the U.S.
At the other extreme, there are many countries with incomes much lower than half our level. Among the poorest countries on earth are Ethiopia (average annual income of $710 per person), Malawi ($600), Sierra Leone ($530), and Tanzania ($610). As these examples may suggest, Sub-Saharan Africa is the poorest region in the world, with an average income of $1770 for the 48 countries comprising the region. Thus, the average American has an income that is more than twenty times greater than the average African.
The two most populous nations on earth, China and India, are also quite poor, despite rapid improvements (especially in China) in recent years. China’s 1.3 billion people have an average income of $4990. While nearly three times as high as Africa’s, it is only about one seventh that in the U.S. India’s 1.1 billion people are poorer still, with an average income of $2880.
In addition to the great differences (inequalities) that separate the average incomes of nations, there is also substantial inequality of income within each country. When examining inequality within the U.S. in Chapter Two, we used shares of income for quintiles (fifths) of the population, and the associated HiLo ratios, as our preferred measures of inequality. The World Bank also provides estimates of quintile shares of income for most of the world’s nations, and we will rely on its estimates here. For the United States, the World Bank gives 5.4 and 45.8 for the lowest and highest quintile shares, implying a HiLo ratio of 8.5. (Recall that the HiLo ratio is the ratio of the top quintile’s income to that of the bottom quintile.) Note that this implies less inequality than the unadjusted Census Bureau figures discussed in Chapter Two (where we saw the HiLo ratio to be about 12). There are two technical differences in the ways the World Bank and the Census calculate these ratios that accounts for the Bank’s estimate of less inequality. The differences need not detain us; what matters here is that the World Bank utilizes the same measurement procedure for all countries so the comparisons are meaningful. (However, these quintile estimates are subject to most of the criticisms leveled at the Census estimates in Chapter Two, and so probably overstate economic inequality, though probably to varying degrees for different countries).
Substantial inequality of incomes characterizes every country in the world, according to the World Bank’s figures. There are only two countries in the world (of the more than 130 listed by the Bank) where the share of income received by the lowest fifth of households exceeds 10 percent. They are Japan (10.6 percent) and the Czech Republic (10.3 percent). In all other countries the average household in the poorest quintile has an income less than half the national average. At the top of the scale, only one country in the world is reported to have an income share for the top quintile that is under 35 percent: the Slovak Republic with 34.8 percent.
The variation in inequality within most countries is, however, surprisingly great. Let’s use the HiLo ratios to give a feeling for the diversity among countries. By this measure, several of the most unequal countries in the world are in Latin America. For example, the highest quintile in Brazil receives 32 times the income of the lowest quintile (recall that for the U.S. the ratio is 8.5): the quintile shares are 2.0 and 64.4. Chile, Argentina, and Mexico are not far behind, with HiLo ratios of 18.9, 18.2, and 19.0. But the most unequal country on earth is to be found in Africa. Namibia, where the top quintile receives 78.7 percent of total income and the bottom quintile a miniscule 1.4 percent, has the astounding HiLo ratio of 56.2.
Two other notably unequal societies are Russia and China. Communist (egalitarian?) China has a HiLo ratio of 10.6, and formerly communist Russia is nearly the same at 10.5, both displaying greater inequality than the U.S.
The most equal countries tend to have HiLo ratios around four. Japan, with a HiLo ratio of 3.4, is the most equal society in the world by this measure. Following close behind are some of the welfare states of Western Europe and Scandinavia. Norway, Sweden, and Denmark sport HiLo ratios of 3.9, 4.0, and 4.3, respectively. Germany, France, Italy, and the U.K. come in at 4.3, 5.6, 6.5, and 7.2.
These examples may suggest as a generalization that the wealthier countries tend not only to have higher incomes but also more equally distributed incomes than poorer countries. As a rough generalization, this may be correct, but there are some notable exceptions. Low income India has a HiLo ratio of 4.7, while (lower income) Ethiopia and Rwanda do even better at 4.3 and 4.0.
How does the U.S. look in comparison to the other countries of the world? Is inequality here noticeably greater? Based on the World Bank data, it appears that the U.S. stands pretty much in the middle of all countries, with about half the countries displaying higher HiLo ratios and half lower. However, critics of inequality in America tend to emphasize comparisons only with the other high income countries of the world, especially the European welfare states. From the available evidence, it is true that inequality is greater in the U.S. than in most of these countries, as the numbers cited above suggest. Do not forget, however, the many defects in this type of data as measures of economic inequality that were spelled out in Chapter Two. Inequality in the U.S. is certainly less than these World Bank quintile shares suggest, but of course that may also be true for the other countries as well. I suspect that more accurate measures of inequality would continue to favor the European welfare states, but the differences would probably not be as great as implied by the differences in HiLo ratios reported here.
In this connection, an important point to keep in mind is that these quintile shares only measure relative inequality within a society, and using them in comparisons across societies with differing average incomes can often be misleading. Consider France. According to the World Bank, the poorest quintile in France receives a 7.2 percent share, while the corresponding quintile in the U.S. receives only 5.4 percent. Nonetheless, because of the higher average income in the U.S., Americans in the lowest quintile actually have higher absolute incomes than the French who are in their lowest quintile. A smaller share of a bigger pie can imply a higher absolute standard of living.
Indeed, one of the most striking implications of these international comparisons is how well off in an absolute sense even low income Americans are compared to most of the people in the world. Consider India, a very egalitarian society (HiLo ratio of 4.7) but one with low average income ($2880). Households in the lowest quintile in the U.S. actually have incomes that are nearly twice as high as the households in the highest quintile in India. That our poor are rich by standards prevailing in most of the low income countries of the world is not adequately appreciated.
If any further evidence is needed to show how rich Americans (and those in a handful of other high income countries) are relative to most people in the world, it is provided by the World Bank’s tabulation of world poverty. The World Bank uses two income thresholds to estimate the number of world poor. People with income of less than $1 per day are said to be in extreme poverty, while those between $1 and $2 per day are in moderate poverty. (These are not the poverty thresholds used to measure poverty in the U.S.) Based on these definitions, the World Bank estimated that in 2001 1.1 billion persons were in extreme poverty and another 1.6 billion were moderately poor. Nearly 45 percent of the people in the world are poor by this very stringent standard!
And it is a very stringent standard, even if we adjust for the fact that it is based on prices prevailing in 1985. The $2 threshold is about $3 per day in 2003 prices, so corresponds to an annual income per person of $1095. For a family of four, this translates to an annual income of about $4400. To put this in perspective, the poverty threshold for a family of four used by the U.S. government in 2003 was about $18,000. Needless to say, few if any of the persons counted as poor in the U.S. using our poverty thresholds are poor by the World Bank standard. Yet 2.7 billion people in other countries are.
When next you hear someone agonizing over the plight of hard-working low income Americans or the struggling middle class, reserve a little sympathy for the majority of people on earth who are so much poorer.
Why Are Some so Rich?
The vast differences in income levels among the countries of the world cry out for an explanation. Often the question is posed as: why are some countries so desperately poor? But that is not really the most instructive way to approach the issue. Poverty has characterized most of humanity throughout its history, and continues to do so in most countries today; it requires no explanation. The anomaly to be explained is the small number of countries which have in recent generations escaped this fate and become relatively rich. We need to understand how they have done this if the poor countries are ever to escape their present impoverishment.
In approaching this issue, a key insight is provided by the tautology (discussed in Chapter One) that a nation’s output (production) is the income of its people. They are two sides of the same coin. Rich nations are rich because their citizens produce a lot of goods and services; poor nations are poor because they produce little. Ethiopia is not poor because other nations have appropriated its resources or exploited it; it is poor because Ethiopians produce very little.
What factors, then, are responsible for high output (income) per person in a country? Innumerable factors can plausibly play some role, but economists believe the most important of these can be classified into four categories.
First is the amount of capital per person (or worker). Capital here refers to the productive resources that are employed in conjunction with labor effort to produce goods and services. Capital includes things like buildings, equipment, power lines, computers, roads, and vehicles, all of which obviously contribute to an economy’s output. In general, the more capital there is per worker, the higher will be output per worker, and thus the higher incomes will be. The entire stock of capital in the United States is valued at roughly $33 trillion (in 2002), so the typical worker’s productivity is enhanced because he or she is able to utilize $240,000 worth of capital in their jobs.
The present capital stock of the U.S. represents the cumulative effects of past investment and saving decisions. Clearly, since the capital stock is nearly three times the annual total annual output of the economy, and only a small part of that output is capital goods, the accumulation of a large capital stock is a gradual and often slow process. Countries cannot become rich quickly.
Capital and labor cooperate to produce output, so it is natural to look to labor as another factor influencing income levels. Here, what is important is the level of productive skills possessed by workers since more skilled workers are capable of producing more. (Economists sometimes refer to the skills of workers as their “human capital” since, by analogy with physical capital goods, human beings can contribute to production over a period of years.)